Independent Order of Odd Fellows of Victoria v Federal Commissioner of Taxation

[1991] HCA 55

HIGH COURT OF AUSTRALIA

Mason C.J., Brennan, Dawson, Toohey and McHugh JJ.

INDEPENDENT ORDER OF ODD FELLOWS OF VICTORIA v. FEDERAL COMMISSIONER OF TAXATION

(1992) 173 CLR 417

19 December 1991

Income Tax (Cth)

Income Tax (Cth)—Assessable income—Derivation of income—Exempt income—Friendly society—Eligible insurance business—Income derived therefrom assessable—Moneys set aside from that income to meet tax liability—Business "of or in relation to the issuing of or undertaking liability under eligible insurance policies"—Whether interest earned on moneys set aside derived from that business—Income Tax Assessment Act 1936 (Cth), ss. 23(g)(i), 116E(1) "eligible insurance business", 116G(1)—Friendly Societies Act 1958 (Vict.), s. 14(3).

Decision

MASON C.J., BRENNAN, DAWSON, TOOHEY AND McHUGH JJ. Section 23(g)(i) of the Income Tax Assessment Act 1936 (Cth) ("the Act") provides that the income of a friendly society is exempt income. That general exemption was qualified in respect of the income year ended 30 June 1985 by s.116G(1) of the Act as it then stood. That sub-section read:

" The assessable income of the year of income of a registered organization being a friendly society shall include so much of the total income (other than premiums) of the society of the year of income as is derived from eligible insurance business of the society."

The term "eligible insurance business" was and is defined by s.116E(1) to mean -

"business of, or in relation to, the issuing of, or the undertaking of liability under, eligible insurance policies".

"Eligible insurance policy" was defined to mean -

"(a) a life assurance policy; (b) an accident policy; or (c) a disability policy, but does not include so much of a policy referred to in paragraph (a), (b) or (c) as is a sickness policy, a funeral policy or an eligible policy".

2. The Independent Order of Odd Fellows of Victoria ("IOOF"), the appellant taxpayer, is a friendly society registered under the Friendly Societies Act 1958 (Vict.). It carries on eligible insurance business among its other activities. The question is whether the income derived by IOOF from the investment of moneys standing to the credit of a fund known as the Life Insurance Management Fund No.2 ("the No.2 Fund") was income derived from eligible insurance business (and, on that account, assessable income) or was part of the general income of IOOF (and, on that account, exempt income). To answer that question, a brief description of the funds and the activities of IOOF is necessary.

3. The Friendly Societies Act contemplates the maintenance of separate funds for the several activities of a friendly society. Section 14(3) provides that -

"all moneys received or paid on account of any particular fund or benefit provided by the rules for (the purposes of life or endowment policies) shall be entered in a separate account distinct from the moneys received and paid on account of any other fund or benefit, and the moneys belonging to any one such fund or benefit shall not be used in any manner for the advantage of any other fund or benefit".

However, the Government Statist is empowered by the sub-section to authorize a transfer of any surplus standing to the credit of such an account "to be used or applied in any manner for the purposes of the same or any other fund or benefit". The rules of IOOF provided for the maintenance of 37 separate funds, 21 of them being described as "Benefit Funds", the other funds being described as "Grand Lodge Funds". The activity in respect of which a fund is constituted is indicated by the name of the fund. Thus, among the Benefit Funds there was a "Flexible Insurance Benefit Fund No.1" into which premium and other fund income was paid and out of which benefits and expenses attributable to the fund were disbursed. The conduct of the respective funds was governed by rules appropriate to each fund. Part 7 of the rules applied to Benefit Funds, the leading provision applicable to all Benefit Funds reading:

"PART 7 - BENEFIT FUNDS

7.1 (a) The Society may, for the purpose of providing for the welfare of its members and their dependants, maintain benefit funds whose nature and circumstances shall be decided by the Grand Lodge in Session. Each Benefit Fund shall be kept clear and distinct from each other fund. The assets of any Benefit Fund may be combined with the assets of another fund, for investment purposes, only with the specific written consent of the Government Statist."

Part 6 of the rules applied to Grand Lodge Funds, the leading provision applicable to all Grand Lodge Funds reading:

"PART 6 - GRAND LODGE FUNDS

6.1 In addition to the various Benefit Funds identified in Part 7 of these rules, the Society may, for the purposes of administering its affairs and of preserving and furthering its objects, maintain Grand Lodge Funds to be used for such purposes as the Grand Lodge sees fit. Each Grand Lodge Fund shall be kept clear and distinct from each other fund but the assets of Grand Lodge Funds may, with the consent of the Government Statist, be combined for investment purposes."

4. The assets standing to the credit of a Benefit Fund must be used for the purpose for which that Fund is established so long as they remain assets of that Fund; the assets standing to the credit of a Grand Lodge Fund can be used "for such purposes as the Grand Lodge sees fit". It appears that moneys standing to the credit of Benefit Funds established in respect of eligible insurance business and contingently required to meet expected tax liabilities were treated as a surplus available for transfer to the No.2 Fund. In a statement tendered to and verified by evidence before the Administrative Appeals Tribunal, Mr Jacob, the Finance Manager of IOOF, explained how the Benefit Funds were applied:

"The actuary did not allow for the accumulation of any surpluses and required same to be distributed to members accounts. To overcome the restriction on reserve accumulation it was deemed prudent by the management of IOOF to establish a separate tax provision repository fund for the various taxable Benefit Funds with the ability to accumulate reserves that could meet, any accelerated or higher tax payments than had been provided for in the accounts."

The distribution of surpluses to members' accounts was evidently regarded by IOOF and the Government Statist and Actuary as being in satisfaction of the rights of the members interested in the respective Benefit Funds as at a date when the accounts of the respective Funds were closed off. That left IOOF (or, more precisely, the trustees of IOOF) with a contingent tax liability to be met in the course of administering the Benefit Funds. The moneys required to meet the contingent tax liability were set aside and transferred to the No.2 Fund as Mr Truslove, who had been the acting Government Statist and Actuary at the relevant time, explained in a statement tendered to and verified by evidence before the Tribunal:

"I am familiar with the establishment of the IOOF Life Insurance Management Fund No. 2 and the reason for its establishment which, as acting Government Statist and Actuary, I approved. ... These management funds ... were designed to be funded by the transfer from the policies insurance funds of an amount calculated to represent tax payable on an accruals basis when in fact tax was payable on a cash basis. These amounts formed the management fund. The money made available from the various other funds of IOOF to the management fund would not always or necessarily have produced income after investment by IOOF through the management fund. This is because, these monies were capable of investment in a range of investments different from those required of other funds. For example the management fund was specifically designed for investment in non income producing capital items."

The Tribunal in its decision recited and clearly accepted the parts of the statements of Messrs Jacob and Truslove set out above. The Tribunal found that the "No.2 Fund was established on the advice and approval of the actuary". The No.2 Fund was a Grand Lodge Fund, the relevant rules, being those contained in r.6.12, reading:

"6.12 LIFE INSURANCE MANAGEMENT FUND NO. 2

6.12.1 There shall be established a Life Assurance Management Fund No. 2 under the control of the Board of Management.

6.12.2 The assets of the fund shall be kept separate and distinct from all other assets of the Society.

6.12.3 The fund shall be invested according to guidelines laid down by the Government Statist and Actuary.

6.12.4 Into this fund shall be paid the provision for taxation as calculated for each financial year, and also any interest earned on this amount.

6.12.5 The fund shall be used for the purposes of paying income tax assessments as advised by the Australian Taxation Office from year to year.

6.12.6 All or part of the surplus generated by this fund may be transferred to any other fund subject to approval of the Board of Management and the Government Statist and Actuary."

The No.2 Fund had to be applied in priority to the payment of tax as assessed (r.6.12.5) but, as the amounts transferred from the Benefit Funds were sufficient to meet contingent tax liabilities, the proceeds of investment of the No.2 Fund would be a "surplus generated by this fund" and available for transfer to other funds pursuant to r.6.12.6. The question in controversy between the parties was whether the sum of $954,439 which was received as interest on the investment of $7,051,724 transferred to the No.2 Fund from Benefit Funds was assessable income or exempt income.

5. The Tribunal held that "the sum of $954,439 being interest earned upon an investment of the No. 2 fund was 'income as is derived from eligible insurance business of the society' and is therefore assessable". An appeal to the Federal Court (limited to a question of law: Administrative Appeals Tribunal Act 1975 (Cth), s.44) was dismissed by majority (Sweeney A.C.J. and Wilcox J., Northrop J. dissenting). From that judgment this appeal is brought by special leave.

6. The criterion of assessability of the income of a friendly society is its derivation from eligible insurance business: s.116G(1). Eligible insurance business is neither a Fund nor a sum of money; it is business consisting in the issuing of or the undertaking of liability under eligible insurance policies or business in relation to the issuing of or the undertaking of liability under eligible insurance policies: s.116E. Income derived from any other business of a friendly society is outside s.116G(1). In applying the criterion, it is erroneous to treat a business or a fund as if it had a legal personality. If that error be made, it facilitates the making of the further error that moneys transferred to the No.2 Fund belong beneficially to the Benefit Funds from which they were transferred. Then it is but a short step to treat the income derived from investment of those moneys as the income of the respective Benefit Funds and hence derived from the respective businesses in respect of which the Funds were constituted. The basic fallacy in this chain of reasoning is that it overlooks the fact that at all material times the money belongs to IOOF alone. It is true that while the money stands to the credit of a Fund it must not be used "for the advantage of any other fund". It is also true that the policy holders concerned with that Fund have the right to have the Fund administered in accordance with the rules. But they have no beneficial interest in the moneys in the Fund. IOOF is the beneficial owner of those moneys. Consequently, a transfer of money from one Fund to another merely alters the powers of IOOF (or its trustees) with respect to the control, investment and application of the money transferred and the application of income or capital gains derived from its investment. Although transfers between Funds might affect the administration of the moneys transferred, income derived from the investment of moneys in any Fund is the income of IOOF and the administration of the income so derived is governed by the rules applicable to that income. The liability of IOOF as taxpayer in respect of income derived from investment of moneys does not depend upon the Fund from which or to which money destined for investment is transferred but upon the character properly attributed to the activity of investment by which that income is derived: is the investment of the money an activity which is part of the taxpayer's eligible insurance business?

7. Clearly, the investing of the money in the No.2 Fund is not the issuing of or the undertaking of liability under eligible insurance policies. Nor is the investing of money in the No.2 Fund business "in relation to" the issuing of or the undertaking of liability under eligible insurance policies. There is no relevant relationship between the derivation of income by investing the money in the No.2 Fund and the issuing of or the undertaking of liabilities under eligible insurance policies. That is not to deny that IOOF's eligible insurance business comprehends all the activities which appertain to the issuing of and the undertaking of liabilities under such policies, including the setting aside of moneys for meeting a tax liability on income derived from carrying on that business and the discharge of that tax liability. But the investing of moneys so set aside before those moneys are applied in discharge of that tax liability is a distinct activity of a character different from the character of an investment made in the course of carrying on IOOF's eligible insurance business. Of course, the investment of money is a usual, if not a universal, feature of insurance business where the proceeds of investment are intended to be applied in or for the purposes of the business. But, as we have seen, the proceeds of the investment of the No.2 Fund were at the general disposition of the Board of Management of IOOF pursuant to rr.6.1 and 6.12.6. The IOOF was under no obligation to apply the income derived from the investment of the No.2 Fund for any insurance purposes, nor was that income needed for the payment of tax on the income derived from eligible insurance business.

8. It is not necessary to determine whether s.14(3) of the Friendly Societies Act empowered the Government Statist to authorize transfers from the Benefit Funds constituted in respect of life and endowment insurance business to the No.2 Fund where those moneys represented contingent tax liabilities on income derived from that business. No challenge was made to the validity of those transfers and, even if they were invalid, their investment was an activity separated, and intended to be separated, from the carrying on of any insurance business.

9. As the investment of moneys in the No.2 Fund was not relevantly related to the issuing of or the undertaking of liability under eligible insurance policies, the income derived from that investment was not derived from eligible insurance business: it was exempt income. The appeal must be allowed and the order of the Federal Court quashed. In lieu thereof, the appeal from the Administrative Appeals Tribunal to the Federal Court should be allowed, the decision of the Administrative Appeals Tribunal set aside and in lieu thereof an order made that IOOF's objection to its assessment to tax for the year ended 30 June 1985 be allowed and that that assessment be amended by reducing the assessable income of the taxpayer by $954,439.

Orders

Appeal allowed with costs.

Set aside the order of the Full Court of the Federal Court made on 26 November 1990 and in lieu thereof:
1. Allow the appeal from the decision of the Administrative
Appeals Tribunal to the Federal Court with costs;
2. Set aside the decision of the Administrative Appeals
Tribunal; and
3. Order that the appellant's objection to its Notice of
Assessment for the year ended 30 June 1985 be allowed and
that the Notice be amended by reducing the assessable income of the appellant by $954,439.